All throughout the epic surge in corn prices, the big Kahoona, Goldman Sachs, where buy means sell, and sell means Goldman's traders are buying everything its clients have to dump, was quiet. That is no longer the case: "we recommend a short May-13 CBOT wheat position vs. a long May-13 CBOT corn position." In other words, Goldman will now be selling May 13 corn. We all know how these recommendations end.
Repositioning for CBOT wheat vs. corn underperformance
Corn production loss in 2012/13 worse than wheat
US and global wheat production will decline in 2012/13 on adverse weather in key exporting regions. However, the US drought is also leading to a significant loss of US corn production. With already low US corn inventories at the end of the 2011/12 crop year, we forecast 2012/13 US corn inventories at critically lower levels than wheat inventories. As a result our price forecast embeds a smaller wheat-to-corn premium than currently priced into the CBOT wheat and corn future curves. In particular, the low US corn production will likely require wheat use in animal feed rations and as a result corn prices to trade back near wheat prices.
Recommending a wheat-to-corn convergence trade
Consequently, we recommend a short May-13 CBOT wheat position vs. a long May-13 CBOT corn position. The biggest risk to this trade is a significant further shortfall in wheat production, including further sharp downward revisions to FSU production and the reinstatement of a Russian export ban for example. However, our wheat-to-corn pricing model, illustrated on page 2, suggests that such a risk may be priced in to a large extent. Assuming a 6% US corn stocks-to-use ratio, our model suggests that the current wheat-to-corn price ratio is consistent with a US wheat stocks-to-use ratio of 18%. Assuming all other items from the USDA's US wheat balance table remain unchanged, this level of stocks-to-use would correspond to US wheat exports rising from the 1,200 mmbu currently forecast by the USDA to 1,400 mmbu, a 5.4 million metric ton increase. To put in perspective, the USDA currently projects Russian production 7.5 MT above its 2010/11 decade low.
Positioning supports this view
Positioning as reported in the CFTC Commitment of Traders report also suggests that CBOT wheat prices may underperform corn prices: net speculative length has increased more for wheat than corn since late May, with wheat positioning near record net long while corn positioning remains less than half of its highs set last year (see page 2). Finally, given the current backwardation and contango in the CBOT corn and wheat curves respectively and our analysis of the seasonal of the wheat-to-corn price ratio, we believe that a May-13 expiration offers the best risk-reward.